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Monday, November 24, 2008

“ I haven’t filed taxes for six years – ever since I been down here.” That was the comment from my co-expat from the States, who had just bought me a drink at my favorite bar in Antigua. I had already heard similar statements from other ex-pats several times in the near past.

“ I have had income every one of those years, so I guess I should file, right?” he continued.He was confiding this to me because I am a retired tax specialist from the States currently residing in Guatemala. My specialty is showing retired persons and/or small business owners ( two diverse groups, I realize ) how to legally reduce and avoid taxes. I stress the words “legally” and “avoid”.As I mentioned to the gentleman above, the difference between tax avoidance and tax evasion is 5 years ( in Leavenworth ).

I explained to my friend above, that a U.S. citizen is expected to file a tax return, no matter where he/she lives in the world, if there has been any taxable income during that year.

That does not necessarily mean that he/she will owe any taxes ( especially if the proper planning has been done ). After hearing his details, I assured my friend, for example, that in his case he would owe nothing. He would also get back almost all the money that had been withheld from his pay during one of those years. He was quite happy to hear that, of course.

In future articles I will cover methods and strategies for small business owners that reduce and eliminate taxes. There are various means, depending on whether the business owned is located in the U.S. or outside the U.S.

For the balance of this article I am going to focus on retired persons and what I consider to be the worst ( and most common ) tax problem for retired individuals ——“Qualified Plan Accounts”. That includes, for example, IRA’s, 401-k’s, 403-b’s, SEP’s, ect. Every dollar removed from one of these plans is taxable and in many cases, causes tax on Social Security. The amount withdrawn can also place an individual in a higher tax bracket,causing still more tax to be owed.It was actually quite ingenious on our government’s part to encourage us to set aside money in a non-taxable account and give us a tax deduction for doing so ( albeit, a very measley one ), knowing that at the age of 70 ½ , they would be forcing us to withdraw much larger amounts which would not only be taxable, but in many cases, would cause tax on Social Security and/or put us in a higher tax bracket. ( So much for the promise from President Roosevelt that “we would never pay taxes on our Social Security” )

Our “wiley” government officials came up with another brilliant “tax creating” idea in 1998. It came in two parts.

First, they gave us a new “qualified plan” called the Roth IRA (sponcered by a Senator Roth ). If you contribute to a Roth IRA, you receive no tax deduction, but the account grows tax free AND you can take the money out TAX-FREE !

Allow me to emphasize that point: you DON’T pay taxes on withdrawals from a Roth account and it does NOT cause tax on other income ( ie: Social Security ) A Roth account also goes tax-free to your children ( or anyone you designate as an heir ) at your death.

The second thing the government said was, in addition to being able to contribute to a Roth (from earned income ), we could also “convert” any of our IRA money ( or any “qualified plan” money that had first been transferred to an IRA account ) in any amount to a Roth account. We would have to pay taxes, of course, on the amount we “converted”. They also told us that the taxes owed on any amount “converted” in the year 1998 could be paid over the next 4 years in four equal installments.

There were many people who “converted” their entire IRA to a Roth account in 1998. That was a BIG mistake on their part ( but it created a HUGH windfall amount of tax revenue for the government ).

Their mistake was not “converting” IRA to ROTH —– that is a GREAT idea! It was how they “converted” from IRA to Roth. By mistakenly “converting” the entire amount in one year, they not only paid ( or owed over the next 4 years ) the HIGHEST tax bracket amount ( assuming a typical IRA account is over $150,000.00 ), but they also put themselves in the highest tax bracket possible on their other taxable income that year.

Most people don’t know that the IRS code allows us to “split up “ an IRA account into as many separate IRA accounts as we would like. For example, a $200,000.00 IRA in 1998 could have been split into four $50,000.00 IRA’s and one could have been “converted” each year for the next 4 years. The total tax paid over the 4 years would be much less than the tax created with the single $200,000.00 “conversion”, because of a much lower tax bracket.Also, by using proper tax planning, we could have planned for exemptions and/or deductions to cover the $50,000.00 “conversions”, thereby eliminating ( or at least reducing ) any tax on the “conversion”.

Actually, after years of research, I have developed a planning strategy that allows one to “convert” any amount of IRA money to a tax-free Roth account and legally pay no tax on the “conversion”. A detailed explanation of the strategy is beyond the scope of this article, but suffice to say I have helped hundreds of people “convert” hundreds of thousands of dollars of IRA money to tax-free Roth accounts without a dollar of tax owed.In that respect, the government’s “brilliant” tax-creating idea has “back-fired” on them. Oh well, what goes around, comes around.

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About Me

I live between Oxford, North Carolina, New York City USA and Panajachel, Lake Atitlan, Guatemala, Central America; build and garden in both. LOVE IT!
Aquarius, Year of the Tiger
Email info and suggestions to CatherineTodd2 (at) gmail (dot) com.